On 12 September 2007 in a paper submitted to the Treasury Committee by Mervyn King, Governor of the Bank of England, he warned the City: “…the moral hazard inherent in the provision of ex post insurance to institutions that have engaged in risky or reckless lending is no abstract concept”. On September 13, 2007, the Bank of England, pushed by HM Treasury and with the acquiescence of the Financial Services Authority, bailed out mortgage lender Northern Rock. What caused this about turn?

Nobody in the City was surprised by Northern Rock’s difficulties, but many were surprised by Mervyn King’s overnight U-turn. His stated policy of avoiding moral hazard was prudent and generally accepted in the Square Mile as wise and right. Foolish risk takers should suffer when they get it wrong.

In 1995 Barings collapsed. The Bank of England did not bail it out. Imagine the outrage if a Tory government bailed out the Queen’s bankers, “Tory toffs looking after their own pin-striped aristocrats” would have been the charge. Central Banks should only intervene when their is systemic risk to the financial system, not to bail out shareholders when things go wrong. Northern Rock put too many eggs in the mortgage securitisation basket and offered mortgages at slim margins. That strategy is now shown to be risky and unsustainable. So why bail it out?

Northern Rock is not merely the victim of illiquidity in the money markets as Alastair Darling spins, investors knew something was wrong months ago, the share price tumbled long before the sub-prime crisis made the headlines. Nor can you argue that the collapse of the Northern Rock would cause systemic crisis. The mortgages would be administered, the householders would barely notice a change in ownership and it is inconceivable that other banks would suffer contagion.

The economic arguments against a bail out such as this have been impressively made by Mervyn King himself, the special circumstances argument is patently political spin. So isn’t it more likely that this is a political decision forced on the Bank of England by Gordon Brown and Alastair Darling to spare their blushes?Northern Rock is a regional bank from Labour’s North-Eastern electoral heartlands. Labour supporting figures are on the board. Sir Derek Wanless, Gordon’s favourite banker, chairs the Risk and Audit committee. Sir Iain Gibson sits on both those committees and was appointed by Gordon to the Court of the Bank of England. As far back as the miners strike it has been seen as a “Labour” bank. In the eighties Conservative ministers were furious when striking miners were told not to worry about their mortgages by Northern Rock – removing a pressure on them to return to work. The Labour movement lauded them for it and for their giving of 5% of profits to North Eastern charitable projects.

Guido suspects that the Treasury pressurised Mervyn King, against his better judgement, to bail out Northern Rock for political reasons. Brown’s Britain is a bigger version of Northern Rock. Gordon’s macro-economic policies are Northern Rock’s borrowing policies writ large. Gordon has mortgaged spending through PFI, government debt has ballooned and the consumer economy is floating on debt secured against over-stretched property prices. It can’t go on for ever…